Does your mother pay for my studies?

For something completely different, here’s a guest post by Maximilian Gödl from the Economics Department at the University of Graz. Really looking forward to more.

Does your mother pay for my studies?

Of course she does. And she would have to pay one way or the other.

“Your mother pays for my studies” was the campaign slogan of the JuLis (never mind) in this year’s student council elections in Austria. It was meant to make Austrian students aware of a simple truth – namely that university education actually costs money which comes mainly from taxes on the working population, i.e. your mother. In a country like Austria, where the government is widely known to create resources from thin air, stating simple thruths can be a sacrilege.

What the JuLis don’t seem to understand, however, is this: Since the income of the currently young is generally too small to cover the costs of their education, they have to get the money from the currently middle-aged one way or the other. The only difference between the existing tax-based system and the alternative tuition-fee system favored by the JuLis lies in the way the money is channeled from your mother to me.

The tax-based system now in place in Austria relies on a government-enforced “generational contract” whereby generation 1 is taxed to pay for the education of generation 2, who in turn will be taxed to pay for the education of generation 3, and so on. Under the alternative system practiced in most English-speaking countries, education is mostly paid for by student loans. Where do the funds for these loans come from? Well, they come from the savings of the middle-aged. So under that system, generation 1 saves to pay for the education of education of generation 2, who will save to pay for the education of generation 3, and so forth.*

In short, the distinctive feature of the tax-financed education system is not that your mother pays, but how your mother pays.

So whether you are in favor for that system or not depends on whether you think that the government does a better job at channeling funds between generations than the market. Given the current predicament of our tax-financed pension system, we should be generally skeptical about generational contracts. The problem with such contracts is that they tend to be exploited by one side at the expense of the other, depending on whoever has the upper hand in the democratic process. On the other hand, my trust in the capital market to allocate funds efficiently is also not limitless, to say the least. Above all, one has to make sure that students from poor households can get loans to pay for tuition fees. You could do that through subsidies, for instance. One should also be concerned that the student loan market doesn’t become too volatile. So these markets have to be pretty heavily regulated.

In my opinion universities should be free to charge tuition fees, mainly because that it’s the only way they can really be independent from political influence. That doesn’t mean that you have to rely entirely on capital markets for financing education. You could give students a tax-financed voucher, for instance. Or you can have the government lend directly to students. (That’s what they do in Australia, sort of.)

But no matter which system is used, it remains true that your mother pays for my studies.

*) Note for nerds: There is a purely theoretical argument in favor of a tax-financed education system from “overlapping generation” models. It is well known that in those models the steady-state real interest rate does not coincide with the socially optimal rate which implies a sub-optimal allocation of resources among generations. A tax-and-transfer system could achieve the optimum at least in principle. I am currently working on such a model.

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2 thoughts on “Does your mother pay for my studies?

  1. Really enjoyed the post. I’d love to see the model if you ever get to it, and would be interested in the particular reason the real interest rate does not turn out to be socially optimal under a market-based solution.

    Probably associated with that: you write that “So whether you are in favor for that system or not depends on whether you think that the government does a better job at channeling funds between generations than the market.” You allude to it a bit later on, but of course it would also seem of vital importance how much of a public good you consider higher education to be, or at least how much market failure occurs in that area – which might go beyond just ensuring that the poor also have access. I would say that this is by far not a trivial question. For instance, is it truly a good with big positive externalities or “simply” a merit good (in the strict sense of the term) that we think everyone should have access to/that individuals are too myopic to purchase on their own, yet which has limited externalities that are not captured by e.g. higher future pay? In the latter case, what is “socially optimal” would clearly be a normative statement.

  2. My answer to Flo’s point would be “yes but no”.
    Yes, the social returns to education may be higher than the private returns. Although I am not so sure that having more doctors, lawyers, and *ahem* economists creates added value for our economy over and above the private gains of those doctors, lawyers and economists. But let’s assume there is such an added value. Then I guess you could still subsidize students to make sure they choose the socially optimal amount of education (for instance through scholarships). You could even give special subsidies to “socially preferred” subjects. So no, I don’t think that’s a valid argument against tuition fees.

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